New Rules of the Road
By Julie Quink, CPA
In 2018, nonprofit organizations face implementation of the first major overhaul of accounting standards in two decades. The goal of the overhaul is to improve the communication of financial results for donors and other outside stakeholders and to emphasize transparency in financial reporting.
With these changes, nonprofit organizations can expect significant changes in financial reporting practices. Donors and outside stakeholders can expect enhanced information on liquidity, access to cash and endowments.
What are the significant financial reporting changes for nonprofits?
Some of the major changes in the new standards encompass net asset classification, liquidity and availability, investment returns, reporting of functional expenses, and presentation of statement of cash flows.
The new accounting standards focus on the existence or absence of donor restrictions as opposed to the type of restriction. The new rules provide for two classes of ‘net assets’ — with donor restrictions and without donor restrictions. Previously, nonprofits have reported three required classes of net assets — unrestricted, temporarily restricted, and permanently restricted.
For underwater endowments, in which the fair value of the endowment at the reporting date is less than the original gift or the amount required to be maintained by the donor or by law, the cumulative amount of losses is netted in assets with donor restrictions under the new classifications. Previously, the accumulated losses were included in unrestricted net assets.
Disclosures relative to underwater endowments now encompass the aggregate amount of original gifts required to be maintained, endowment spending policies, and discussion of actions taken or strategy relative to the underwater status of the endowment. For the nonprofit, a concern may be that the status of and strategy of managing underwater endowments is highlighted in the new financial-statement disclosures.
The goal of the change is to simplify tracking and reporting of donor restrictions and also to enhance disclosures on the nature, amounts, and types of donor restrictions.
Liquidity and Availability
Quantitative and qualitative information is required under the new standards relative to liquidity and availability of liquid assets, which are typically cash and investments.
The qualitative disclosures require analysis of how the organization manages its liquid assets to meet cash needs for expenditures within one year of the statement of financial-position date. The quantitative information regarding the liquid assets and their availability to meet the current-year needs can be presented on the face of the financial statements or in the notes to the financial statements.
Donors, grantors, creditors, and other stakeholders want to understand that these nonprofit organizations that they are evaluating have adequate financial resources to meet obligations as they become due. For the nonprofit organization, a concern is that this liquidity information can highlight potential liquidity shortfalls, which may affect future donations and grants.
Investment income is to be reported net of internal and external investment expenses. This has been an optional presentation under current standards. The requirement to disclose investment expenses net in investment income has been removed. The netting of fees against income does not suggest that nonprofits should not still manage and monitor investment fees, but assists in eliminating the burden of trying to identify embedded investment fees.
Currently, only health and welfare organizations are required to report expenses by function. Under the revised standards, all nonprofits must report expenses by function and must disclose the methodology used for the allocations to program and overhead expenses in the notes to the financial statements.
Nonprofit organizations should have been allocating expenses to programmatic and administrative expenses even though not required to detail the expenses by function. The requirement for functional reporting and disclosures may require nonprofits to review their allocation policies for consistency.
Statement of Cash Flows
The new rules continue to allow nonprofits to choose the method, direct or indirect, by which they present operating cash flows. The new guidance does eliminate the need to add an indirect reconciliation if using the direct method in presenting operating cash flows.
By streamlining the requirements, it is believed that the statement of cash flows will be a more useful statement and result in a reduction of costs to the nonprofit to prepare the financial statements.
The new accounting and reporting standards are intended to provide more transparency to donors and other stakeholders. These changes may, however, have a significant time and financial impact on nonprofit organizations as they implement the new requirements.
Julie Quink, CPA is the managing principal of Burkhart, Pizzanelli, P.C., specializing in the accounting and consulting aspects of the practice. She is also a certified fraud examiner.